40 Years Ago Today: Nixon Kills Dollar-Gold Peg

With apologies to dandy Sgt Pepper:
It was forty years ago todayThe dollar-gold standard went awayIt's been going in and out of moneyFor crisis-hit countries it ain't funnySo may I reintroduce to youThe act you've forgotten all these yearsTricky Dicky's dollar-gold killing day

Well this year has yielded a bumper crop of Nixon-era anniversaries with vast implications for the world economy. First came ping-pong diplomacy. Now, 30 years ago today on 15 August 1971, we had Richard Milhous Nixon eliminating the dollar-gold standard. This act not only destroyed the Bretton Woods system of exchange rates pegged to the dollar and, in turn, to gold, but also paved the way for our current system of free(r) floating currencies. (Paging Fred Bergsten.) Suffice to say that things have not been the same on planet Earth since that momentous if sometimes ill-recalled event.

According to some, exorbitant privilege was further extended on this date (which set the stage for John Connally's now-famous remarks about the dollar) was to allow America to print unlimited amounts of greenbacks while maintaining its reserve currency status. Whether you agree or not, it was a most important day in shaping the future course of globalization as we know it. From Buttonwood of the Economist:

Forget Watergate. For economic historians, Richard Nixon’s place in history is secure. He was the president who, 40 years ago, severed the link between global currencies and gold and ended the fixed-exchange-rate system.

Under the Bretton Woods regime, world currencies were pegged to the dollar, which in turn was tied to a set price of gold. Central banks had the right to convert their dollar holdings into bullion. But on August 15th 1971 Nixon, in the face of economic difficulties, closed the gold window, devalued the dollar against bullion and imposed a 10% surcharge on imports. The era of paper money and floating exchange rates had arrived.

In the wake of the Latin American debt crisis, the Asian financial crisis, the subprime crisis, and whatever crises du jour, you do have to wonder if the US exposed all of us to more currency-induced instability than would have been the case had its external imbalances not grown too large to maintain a credible dollar-gold peg. Ah, but that's all gone now...

The Bretton Woods founders had believed that floating rates would be dangerously unstable. But Friedman argued that, provided sensible policies were followed, speculators would act as a stabilising force, preventing currencies from departing too far from fair value.

Let me offer the inevitable counterfactual: Has it been a change for the better? While some of the more persnickety may quibble, it's notable that even this free-market-oriented publication admits that the dollar-gold standard's demise has augured far more financial crises than when it was in place (at least in the industrialized world IMHO):

By contrast, there were no asset bubbles to speak of in the Bretton Woods era and (not coincidentally) scarcely any financial crises. Between 1945 and 1971, the worst calendar-year loss suffered on Wall Street was a 14.1% decline in 1957.

Perhaps the lesson of the past 40 years is that neither a fixed nor a floating-rate system is a panacea. Many governments have used currency pegs as a shortcut towards economic credibility without the structural reforms needed to ensure their economies remained competitive. Floating rates create the temptation for governments to drive down their currencies and grab a bigger share of world trade. That temptation is very strong at the moment and could lead to further political tensions if America opts for another round of quantitative easing. In a world of competing devaluations, gold keeps driving higher. It surged above $1,800 an ounce on August 11th. In terms of the old gold measure, the dollar has devalued by 98% since the end of the Bretton Woods era.

Nixon's legacy lives on, for better or worse and despite others' (stated) intentions to reform it. So let me reintroduce to you the one and only...Tricky Dicky.